Stock Options for Everybody?

I have been thinking about stock options today, and I had three subjects I wanted to cover, which I’ll separate into three posts:

One of the central questions every entrepreneurial company asks itself is: do we believe in stock options for all employees, or just key ones?

I have seen both approaches and heard justifications for either:

  • “We believe in everybody having ownership incentives,” or
  • “Some jobs are mundane and options won’t change the behavior of people filling them.”

I guess I don’t have a fixed position on which approach to follow. A company should choose how widely to spread options based on its culture and whether the leadership team and board think that options provide a true motivation for employees to behave like owners.

In the first dot.com wave, I was living in Silicon Valley and it seemed like the model was “stock options for all.” I knew secretaries who became millionaires—literally—when their companies were acquired or IPO’d. They were nice enough people and put in their time, but did they really add equivalent value to the company, or were they just in the right place at the right time? Come the dot.com bust, some of the companies didn’t do well and their previously generous stock option policies looked like a wealth transfer from shareholders to low-level employees of non-performing companies.

The dot.com bust, and Enron and WorldCom scandals were followed by Congressional hearings and media outrage that people in business were making money. Sarbanes-Oxley and less formal pressure on private sector compensation led to tighter regulation of stock option grant prices. Even though Sarbanes-Oxley was sold to us as being intended only for public companies, even early stage companies now pay to have annual 409A analyses performed to establish a fair market value (FMV) for a company’s options. There is even a new profession—Valuation Specialist—and a training and certification industry to support it.

Another important change to stock options was an opinion by the Financial Accounting Standards Board (FASB) that companies should expense stock options, as if they are cash outlays. I’ll write about the wisdom of this in a separate post.

As a result of these policies, it seems—anecdotally—that companies became less generous in their option grants. Fewer options were given and they were given to fewer employees.  (If ever I retire to academia I may study this subject to see if the data support the anecdotes. If anybody knows of such a study, please let me know and I’ll publicize it. Found one: here.)

For a decade, these policies had the perverse effect of reducing the sharing of wealth and class mobility–the opposite of what policymakers say they want. Now that these policies have been absorbed into the private economy it appears that companies are returning to more generous option granting policies. Businesses and markets do eventually adjust to whatever the rules are and companies can now go back to spreading the wealth, if they so choose.

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